Why Commodity Cost Increases Won’t Impact the CPI Anytime Soon

Last month Purcashing.com said that "More than half of the buyers in Purchasing's monthly survey (57%) report that commodity prices rose in February, pushing the monthly commodity price index up to 75.9 this month, the highest point for that index in more than two years. Metals and plastics are on the rise most, with 50% of buyers polled saying steel prices are on the rise in February." Intuitively, we would expect continued commodity price increases to rather quickly pass through to the price that consumers pay for finished goods and thereby foreshadow an increase in inflation. Not so fast.

This morning's WSJ claims that "Raw materials remain a relatively small slice of the larger cost equation for most producers and, more importantly, the U.S. and many other major economies are still not seeing the sort of strong upturn in demand that would be needed to support a pass-through of those costs." Despite the fact that "this time, [commodity] prices are going up unusually fast. Over the past six months, core intermediate producer prices -- prices those manufacturers pay for such things as steel, textiles and lumber -- rose 2.9%, which translates to an annualized increase of 5.8%, according to the Bureau of Labor Statistics ... [The Journal also quotes] Joseph Carson, an economist at Alliance Bernstein, [who] wrote in a recent note to investors that, by contrast, it took more than two years during the recovery from the last recession before core intermediate prices at the lower stage of processing increased at that pace."

While this is good news for inflation -- at least for the time being -- the article offers further insight to the complexities of recovery and the impact of the past two years on the manufacturing sector. "Last year, capacity utilization rates in the U.S. manufacturing sector fell to a record low of 65.4%. This figure has been climbing in recent months, due to the recovery, but capacity use in January was still a relatively low 69.4%. There is generally room to produce more with minimal cost." And in response to increases in steel prices, John Lichtenstein, an economist with Accenture, is quoted saying "if steel prices do keep moving up, customers will simply redouble their efforts to find less-expensive sources. 'There is a lot of capacity [in the steel industry] and competition to sell at the lowest price'." And it's fair to predict that competition in general will keep most pricing in check throughout recovery.